eBusiness Weekly
Dr Keen Mhlanga
The Zimbabwean financial system comprises of foreign exchange markets, money markets and capital markets. Despite being a mixed economy and suffering the Covid-19 saga, the economy is recovering in 2021 mainly boosted by higher agricultural production, improved capacity utilisation in industry, and stabilisation of prices and exchange rate.
Apart from being recognised as one of the richest nations in land and mineral resources, it came to financial advisors’ attention that probably the country is not fully exploiting opportunities within the markets hence after proper research the term, “derivatives market” came to the surface.
The Financial Securities Exchange (FINSEC) enables an order-driven market that is anonymous. The counterparty will never be revealed to the contract writer, and all facts will be kept private by the clearing participants.
During trading hours, contract writers will submit, buy and sell orders into a central electronic order book that will be cleared by FINSEC Clearing Members utilising terminals on their premises.
The Automated Trading System will match these orders, and execution prices will be calculated. The FINSEC matching engine matches buy and sell orders based on a tight price/time priority criteria. The buy order with the highest purchase price is executed first, followed by the sell order with the lowest selling price.
FINSEC continues to lead the way in extending and widening the local capital markets by developing new products and services. FINSEC’s derivatives products will provide investors additional options and guarantee that Zimbabwe regains its rightful role in the securities market.
A derivative is a contract between two parties which derives its value from an underlying asset. The derivatives market refers to the financial market for financial instruments such as futures contracts or options that are based on the values of their underlying assets.
Derivatives markets make use of instruments commonly divided into four parts namely futures, options, swaps and forwards. Options are financial derivative contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price (referred to as the strike price) during a specific period of time.
The general definition of derivatives means to derive something from something else. Futures contracts are standardised contracts that allow the holder of the contract to buy or sell the respective underlying asset at an agreed price on a specific date. The parties involved in a futures contract not only possess the right but also are under the obligation, to carry out the contract as agreed.
The contracts are standardised, meaning they are traded on the exchange market. Swaps are derivative contracts that involve two holders, or parties to the contract, to exchange financial obligations. Interest rate swaps are the most common swaps contracts entered into by investors.
Swaps are not traded on the exchange market. They are traded over the counter, because of the need for swaps contracts to be customisable to suit the needs and requirements of both parties involved. Forwards contracts are similar to futures contracts in the sense that the holder of the contract possesses not only the right but is also under the obligation to carry out the contract as agreed.
However, forwards contracts are over-the-counter products, which means they are not regulated and are not bound by specific trading rules and regulations. Since such contracts are unstandardised, they are traded over the counter and not on the exchange market. As the contracts are not bound by a regulatory body’s rules and regulations, they are customisable to suit the requirements of both parties involved.
Derivatives market also has its participants popularly dived into four sections. First are the hedgers followed by speculators, arbitrageurs and margin traders. Hedging is when a person invests in financial markets to reduce the risk of future price movements.
Speculation is the most common market activity that participants of a financial market take part in. It is a risky activity that investors engage in. It involves the purchase of any financial instrument or an asset that an investor speculates to become significantly valuable in the future. Speculation is driven by the motive of potentially earning lucrative profits in the future.
Arbitrage is a very common profit-making activity in financial markets that comes into effect by taking advantage of or profiting from the price volatility of the market. Arbitrageurs make a profit from the price difference arising in an investment of a financial instrument such as bonds, stocks. In the finance industry, margin is the collateral deposited by an investor investing in a financial instrument to the counterparty to cover the credit risk associated with the investment.
Risk is a characteristic feature of all commodities and capital markets. Over time, variations in the prices of agricultural and non-agricultural commodities occur as a result of interaction of demand and supply forces.
The last two decades have witnessed a many-fold increase in the volume of international trade and business due to the ever-growing wave of globalisation and liberalisation sweeping across the world.
As a result, financial markets have experienced rapid variations in interest and exchange rates, stock market prices thus exposing the corporate world to a state of growing financial risk especially in volatile economies as Zimbabwe. Increased financial risk causes losses to an otherwise profitable organisation.
This underlines the importance of risk management to hedge against uncertainty. Derivatives provide an effective solution to the problem of risk caused by uncertainty and volatility in underlying asset. Derivatives are risk management tools that help an organisation to effectively transfer risk. Derivatives are instruments which have no independent value.
Their value depends upon the underlying asset. The underlying asset may be financial or non-financial. The use of derivative markets as a strategy to win over and improve the capital market has been spread out by other countries as India, Ukraine and Vietnam.
Derivatives markets in India have been in existence in one form or the other for a long time. In the area of commodities, the Bombay Cotton Trade Association started futures trading way back in 1875. In 1952, the Government of India banned cash settlement and options trading.
Derivatives trading shifted to informal forwards markets. In recent years, government policy has shifted in favor of an increased role of market-based pricing and less suspicious derivatives trading.
The first step towards introduction of financial derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance, 1995. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2001 on the recommendation of L C Gupta committee.
Securities and Exchange Board of India (SEBI) permitted the derivative segments of two stock exchanges, NSE3 and BSE4, and their clearing house/corporation to commence trading and settlement in approved derivatives contracts.
Initially, SEBI approved trading in index futures contracts based on various stock market indices such as, S&P CNX, Nifty and Sensex. Subsequently, index-based trading was permitted in options as well as individual securities. The trading in BSE Sensex options commenced on June 4, 2001 and the trading in options on individual securities commenced in July 2001. Futures contracts on individual stocks were launched in November 2001.
The derivatives trading on NSE commenced with S&P CNX Nifty Index futures on June 12, 2000. The trading in index options commenced on June 4, 2001 and trading in options on individual securities commenced on July 2, 2001. Single stock futures were launched on November 9,2001.
The regulatory framework in India is based on the L C Gupta Committee Report, and the J R Varma Committee Report. It is mostly consistent with the IOSCO5 principles and addresses the common concerns of investor protection, market efficiency and integrity and financial integrity. Equity derivatives market in India has registered an ‘‘explosive growth” and is expected to continue the same in the years to come.
Introduced in 2000, financial derivatives market in India has shown a remarkable growth both in terms of volumes and numbers of traded contracts. NSE alone accounts for 99 percent of the derivatives trading in Indian markets. Looking back at the last four years, it can be worked out that these figures reflect that the growth rate was 29 percent in 2006, 19 percent in 2006, 12 percent in 2005, and 9 percent in 2004.
The turnover of the NSE derivatives segment in 2003-04 stood at Rs. 2130610 crores. It grew to an astonishing level of Rs.13090477 crores during the year 2007-08, displaying a more than six-time increase over the five-year period. The derivatives turnover on the NSE has surpassed the equity market turnover.
Significantly, its growth in the recent years has surpassed the growth of its counterpart globally. The turnover of derivatives on the NSE increased from Rs. 23,654 million (US$207 million) in 2000-01 to Rs. 130,904,779 million (US$3 275 076 million) in 2007-08.
India is one of the most successful developing countries in terms of a vibrant market for exchange-traded derivatives. This reiterates the strengths of the modern development of India’s securities markets, which are based on nationwide market access, anonymous safe and secure electronic trading, and a predominantly retail market.
Derivative instruments will benefit investors in some aspects: risk prevention and help them to finalise profits before unexpected fluctuations, exchange rate gap limitation and avoiding risks from exchange rate movements, or speculators will prefer earning profits in selling or buying within short time.
Moreover, transparency on the derivative market need to be enhanced for investor information reliability. In the development trend of digital transformation, digital economy and e-commerce 4.0, internet of things and Digital technology platform has supported much for the development of derivatives market, as well as data privacy solutions for investors especially focusing on the Vietnam derivative market structure.
Although there are risks for participants: technology, credit risks, liquidity risks, systemic risks, we also see that the development of global derivative markets increasing. Looking at exhibit 1, we find out that Indian, European (Eurex}, USA and China still in the top biggest derivative markets.
Application of derivative can eb enhanced with the period of Information Technology (IT) and the procedure of using derivatives is going digital. First, global derivative markets such as US market have been affected by many factors such as CPI, GDP growth, lending rate and SP500, including factors from crisis. For instance, we need to reduce inflation to increase trading volume of total future and option.
Next, for emerging markets, looking at Vietnam derivative market as an example for development. After 3 years of operation, the derivative stock market had a very good growth, exceeding the expectations set. The market has increasingly shown its role as a risk prevention tool, positively contributing to stabilising the underlying market and attracting the attention of domestic and foreign investors.
Trading volume on the derivative stock market has a strong growth rate, the first 7 months of 2020 reached over 165,000 contracts / session, an increase of 86.5 percentt compared to 2019 and 15 times more than the first year. open the market (average nearly 11,000 contracts / session). Market transactions are particularly active whenever the underlying market has strong volatility.
Liquidity continuously set new records and the latest record was 356,033 contracts on July 29, 2020, a figure that many previously developed markets took decades to achieve.
Stock market of financial derivatives in Ukraine still develops. Analytical market reviews, materials of periodicals, resources of the Internet are the informational and methodological basis of the measures of legislative regulation on the stock market of financial derivatives in Ukraine.
The slow development of the stock market of financial derivatives in the country significantly reduces the competitiveness of Ukraine on the market of foreign investment capital. The stock market of financial derivatives in Ukraine is still in its infancy. In the short history of its formation the necessary infrastructure has already been built up by the joint efforts of state institutions and market participants, a certain legislative framework has been established, and large-scale propaganda work is being conducted to attract domestic investors of individuals and legal entities towards the possibilities of investment in financial derivatives.
In contrast to the global derivatives market annual growth, derivatives market in Ukraine needs to be improved in the nearest future. Global derivatives markets have long been using alternative instruments, such as contracts for difference, over-the-counter options. Situation at Ukrainian commodity derivatives market has not changed since that. Today the government agency Agrarian fond is using forward contracts in agricultural intervention program. In the past 10 years, Ukrainian commodity exchanges have not implemented any futures or options on commodity assets. Today Ukrainian Exchange is the leading stock exchange at the domestic derivatives market.
The use of foreign experience of trade by financial derivatives in Ukraine is a prerequisite for effective implementation for the integration processes on the financial market of Ukraine into the world economic space and strengthening of international monetary and financial relations. As a result of institutional reforms in Ukraine, the main purpose of which is the formation of a civilized economy of a market type, the stock market of financial derivatives began to play an important role. At this stage, this segment in Ukraine has already been formed in a certain way: there are trade stock exchange electronic systems, securities issuers, numerous investment companies and banks, as well as state and municipal organizations, and there are investors who are interested in the best for their placement. The stock market of financial derivatives is a special institutional form of the financial market, in which the exchange assets of the highest quality (securities, currency, precious metals, etc.) are rotated, and transactions are carried out by professional participants. The stock exchange serves as a trading, professional, as well as regulatory and technological core of the stock market of financial derivatives.
Derivative markets snag in Zimbabwe because the country faces numerous drifts, hindrances and challenges to the trading of derivatives.
Founder and chairman of FinKing Financial Advisory ; [email protected]
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